Why so Glum? The 2018 midterm election is finally behind us, and proved to be just as dramatic as would befit today’s hyper-charged political environment. Moreover, the final results pretty much assure that the drama coming of Washington DC will not diminish over the next two years of the Trump administration. Indeed, without even taking a breath, it feels as if we are already in the run up to 2020. Will the Democratic takeover continue? Will the Republicans be able to hold the Senate and/or the Presidency? While President Trump’s actions in the months ahead will be a major determinant of what happens in 2020, the outcomes will depend even more on where the economy heads over the next two years. Beacon Economics’ outlook for the U.S. economy hasn’t changed much over the course of 2018, despite the fact that we are on the edge of the longest economic expansion in the nation’s history. Growth has progressed at a steady, sustainable pace since the 2015 commodity bust and mild economic slowdown that occurred that year. Growth in the last quarter of this year is expected to come in at slightly less than 3%, with growth for the entire year reaching 3.2%. This modest jump is being driven by the fiscal stimulus plan passed by congress at the end of 2017. Outside of the rapidly growing Federal budget deficit, the U.S. economy looks to be well-balanced in terms of the structure of growth with solid fundamentals including private sector debt levels, consumer savings rates, rising wages, the overall pace of homebuilding, and business investment. Unemployment is low—but job growth remains steady.
United States Forecast
By Christopher Thornberg, PhD | Beaconomics | winter 2018
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CREATING A STRONG ECONOMY
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In short, Beacon Economics’ forecast remains boringly positive, and yes, that outlook is expected to stay in place though 2020. This isn’t optimism. Rather, we don’t have any real reason to think otherwise.
The only major short-term worry has been wrapped around the direction of U.S. trade policy, but the worst scenarios have not materialized. Rather than unilaterally pull out of NAFTA as threatened, the United States instead negotiated a new trade agreement with our two neighbors and largest trading partners that, thankfully, looks almost exactly like the old trade agreement. A brewing trade fight with the European Union that began with steel tariffs has also settled down, and there are now discussions about renewing talks and working towards a new trade agreement. It sounds a lot like T-TIP—the EU-U.S. trade negotiations canceled by President Trump in one of his first acts in office—but this one will likely be better.
Yes, the China trade dispute is still brewing. But even a major trade war with China would not be sufficient to end the current economic expansion. The United States exports fairly little to China—only 8% of all the nation’s exports. And what does get shipped out typically doesn’t have a long supply chain. The greater threat comes from the fact that the United States sources 20% of its manufactured imports from China. But the tariff-increased costs to U.S. importers have been largely offset by a 13% depreciation in the Yuan relative to the U.S. dollar. And even as this article is being penned, there are reports, albeit few specifics, of a possible breakthrough in negotiations.
All said, from a technical or data standpoint there is not much change in Beacon Economics’ forecast for the U.S. economy. The framing of the outlook is another story. While little has changed in the actual economy, much of the public discourse surrounding the economy has taken a sharp turn for the worse. This new wave of pessimism has likely been driven by the sell-off in the stock market, slowing home sales, and rising interest rates. Yet, as we see it, these short run trends do not amount to anything that could truly threaten the current expansion.
Consider rising interest rates. Mortgages are now hovering just below 5%, up one percentage point from where they were 2 years ago. But while this is a recent high, it is hardly an historic one. In fact, it is still lower than at any time between 1968 and 2008. Rates are higher but they certainly aren’t high. And it isn’t surprising that rates have drifted up given that the economy has been growing well and there has been a sharp increase in Federal borrowing.
One wrongly assumed reason for rising rates is inflation. After years of inflation tracking below the Fed- targeted pace, price growth finally increased above the 2% mark. This should have made investors more confident as deflation is less of a risk. Instead, it created a panic about the potential for further increases. They need not have worried: the most recent numbers now show inflation back below the 2% range. Beacon Economics expects inflation to remain weak over the next few years. Oil prices are once again down based on high levels of U.S. output. Money supply growth is also very constrained at the moment. And yes, unemployment sits at an extremely low 3.7%—but if this were going to have an effect, we would already feel inflationary pressures on the economy. Add it up and we don’t see much chance for rates to continue their upward drift. Moreover, the Federal Reserve seems to be taking the hint from the flattening yield curve and have been signaling a gentler future path on short run rates.
The U.S. housing market has slowed as a result in the bump in mortgage rates, which has created considerable consternation. However, there is a big difference between a housing pause and a housing bust. The U.S. housing market is not overpriced, nor has there been much risky lending – or lending in general – occurring. The pace of building has been reasonable, so there is no excess supply to worry about. That the market is responding to changes in interest rates is a good thing. Prices need to adjust to a higher carrying cost; once that happens, the market should get back on track. The slowing pace of sales is part of that process.
As for the stock market sell off, it’s quite amazing that the recent dip has created such a wave of concern as it is no less than the sixth major sell off since the Great Recession ended. And this says more about the stock market than the economy. Excessive growth in equity prices followed by excessive sell-offs is the new normal in today’s high-speed electronic trading environment. There has also been a lot of good news for corporate America recently. Corporate taxes were cut sharply a year ago and gross profits are growing again after being flat last year.
So, for now, Beacon Economics is forecasting the expansion to continue and, barring some unexpected external impact, does not anticipate any major change in economic growth leading up to the 2020 election… for better or worse.
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